Question

Imagine a situation where a neighbor has an ugly tree that you would like to remove. You complain but your neighbor likes her tree. Now suppose that she has the legal right to keep it; then, according to the economist Ronald Coase’s analysis, you would have to pay her to remove it. (Case 3 & 4 below) If you have a right to protection from her pernicious tree, then she can pay you to tolerate it. (Case 1 & 2 below)

What might be the potential problems of Coase’s solution (private bargaining/market transaction) to deal with this type of externality?

Answer 1

The assignment of property rights enables the distribution of wealth. Though potentially an attractive solution, it is unlikely that the Coase Theorem can solve many of the inefficiencies associated with externalities. In reality, there are a number of problems that would limit the success of a Coasian Solution.

Difficulty in Assigning Property Rights:

Who should be given property rights is a tough decision. Different perspective favors the different view of assigning property rights. This is one of the major problems related to Coase's Theorem.

Holdout Problem:

The person that has the property right might take undue advantage of the rights. This can be harmful for the other person.

The Free Rider Problem:

In Coase Theorem, there is a problem of free rider. The one who is not assigned with the property right might find out a way to free ride.

"Higher than Zero" Transaction Costs:

The assumption of zero transaction cost is not realistic. So, this is one of the problem with the Coase Theorem.